Image credit. L'Arroseur Arrosé.
Rightly, in my opinion, Arnold Kling is unhappy with the mainstream
ultra-Keynesian treatments of the financial crisis and its aftermath,
whose
all-purpose causal variable is a glut of savings and a dearth of government spending.
By contrast, he favours the explanation offered by Jeffrey Friedman and Wladimir Kraus in their book Engineering the Financial Crisis:
The Friedman-Kraus story is one in which regulators suffer from the socialist calculation problem. With risk-based capital regulations, regulators determined the relative prices of various investments for banks. The prices that regulators set for risk told banks to behave as if senior tranches from mortgage-backed securities were much safer than ordinary loans, including low-risk mortgage loans held by the bank. The banks in turn used these regulated prices to guide their decisions.
In 2001, the regulators outsourced the specific risk calculations to three rating agencies–Moody’s, S&P, and Fitch. This set off a wave of securitized mortgage finance based on calculations that proved to be wrong.
Friedman and Kraus challenge the basic mindset not only of DeLong but of 99 percent of all economists. That mindset is that the socialist calculation problem, if it matters at all, only matters for full-on socialists, not for regulators in an otherwise capitalist system. In the conventional view, regulators can fail for ideological reasons, or because they are manipulated by special interests. But Friedman and Kraus offer a different thesis. When information discovery is vital, regulators, like socialist planners, are doomed to fail because they are unable to mimic the market’s groping, evolutionary approach to learning.
The source.
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